The present invention is directed generally to a system and method for predicting the profitability of insurance coverage and, more specifically, to a system and method for calculating or deriving a score that is predictive of the future profitability of commercial insurance to be issued to a potential, or reissued to an active, policyholder. The future profitability of commercial insurance can be defined as an assessment, on a prospective basis, of whether a policyholder is going to be charged too much, or too little, as is generally determinable by conventional insurance company pricing methodologies using standard and traditional methods to establish premiums, in relation to that particular policyholder's expected losses.
Commercial insurance provides coverage for many different types of exposures. These include several major lines of coverage, e.g., property, general liability, automobile, and workers compensation. There are many other types of specialty coverages and many more types of subcoverages within the major lines of coverage.
Ideally, an insurance company would price a coverage based on a policyholder's future losses, i.e., the price should be a function of the loss potential which can never be completely known in advance, hence the introduction of risk. The more accurate assessment of that risk, then the more certainty of profitability of the individual insurance policy. The premiums to be paid by the policyholder for the coverage should reflect this risk. That is, higher premiums should be charged for high-risk policyholders while lower premiums should be charged for low-risk policyholders.
The problem of how to adequately price a coverage is challenging, often requiring the application of complex and highly technical actuarial transformations. The technical difficulties with pricing coverages are compounded by real world marketplace pressures such as the need to maintain an “ease-of-business-use” process with policyholders and agents, and the underpricing of coverages by competitors attempting to buy market share.
In the insurance industry, there are generally two approaches for determining the appropriate premium, or pricing, in relation to the insurance risk for a specific major coverage. The first approach is to price the underlying exposure being insured by the particular coverage, e.g., the business property to be insured for property related losses. The second and less practiced approach is to price the coverage based on certain characteristics or practices of the owner of the business property to be insured.
Under the first approach, pricing is based on tangible factors such as the square footage of the property, location of the property, number of vehicles and number of employees. These tangible factors are quantitative and, for the most part, easily capable of measurement. Under the second and less practiced approach, while the exposure characteristics of the first approach may in fact set a base premium level, the final determination of the price of the coverage is further determined as related to certain characteristics of the business owner and the business practices of the business itself. For example, the premium for a particular coverage may depend on how conservative and careful the business owner is in conducting his or her business operation. That is, a more profitable insurance policy is more likely to result from a conservative and careful business owner, which characteristics should be reflected in the determination of each such policyholder's final price.
Despite the availability of alternative pricing methodologies, the insurance regulatory system is based on the first approach, i.e., pricing the exposure, while relegating the business practices and business owner characteristic aspect of pricing to underwriting judgment and expertise. Thus, in the current marketplace little practical emphasis is placed on the business practices and business owner characteristic aspect of pricing coverages.
In addition, the insurance industry has not effectively included the use of external data sources in the estimation of the profitability of a commercial insurance policy, or in other words, the determination of an appropriate premium for a particular commercial insurance policy. External data sources offer one of the best opportunities to obtain the characteristics of a business and or the practices of an owner of the business property to be insured, which is essential for practicing the second approach to pricing as described above. While commercial insurance companies have occasionally looked to non-traditional factors to supplement their conventional pricing methods, such use has been at best haphazard, inconsistent, and usually relegated to a subjective perspective of an underwriter. In the commercial insurance industry, these practices have resulted in pricing methods that, although occasionally using non-traditional factors, are generally specific to the data and business practices of a particular insurance company.
Accordingly, a need exists for a system and method that performs a complete profitability evaluation that does not rely on conventional commercial insurance pricing methodologies. A still further need exists for such a system and method that utilizes external data sources to generate a generic statistical model that is predictive of future profitability of commercial insurance coverages, independent of a particular insurance company's internal data, business practices, and particular pricing methodology. A still further need exists for such a system and method that can be used to augment conventional commercial insurance pricing methodologies to quantitatively include through the use of external data sources business owners' characteristics and business practices, and other non-exposure-based characteristics.
In view of the foregoing, the present invention provides a quantitative system and method that employs data sources external to an insurance company to either independently or more accurately and consistently predict the future profitability of commercial insurance on a per policyholder basis. The present system and method predict profitability using a statistical model that is developed from external data sources independent of a particular insurance company's internal data, business practices, and particular pricing methodology.